The Shift to Quality Assets

During the pandemic, quality has taken a back seat for many investors amidst reopening anticipation. At various points over the past 18 months, both highly speculative growth stocks and deep value “reopening” names have led the market higher. During early cycle periods, it is common to see those names most punished during a downturn recover the most in percentage terms, leading to short-term underperformance of more “boring” dividend growers and traditional market leaders. Citi analysts believe this trade is largely over now.

Cases of the delta variant of COVID-19 are rising just after we have reached “peak growth” in the global economy. Neither of these major issues are crises, but both suggest that important shifts in portfolios are necessary as we enter a mid-cycle period of somewhat slower, but sustainable growth. 

Consistent with this view, Citi analysts are making a major “Quality Shift” as we move past the last 12 months that favored COVID-19 recovery and mean reversion equity trades.

As part of “Quality Shift”, Citi analysts are increasing allocations to US large cap shares while remaining underweight in riskier and more highly leveraged US small and mid-caps. This strategy requires selectivity and Citi analysts prefer the health care sector which trades at a deep discount to other growth equities and offers potential downside protection to boot.

Citi analysts also favour dividend growth equities given their ability to grow dividend payouts combined with the reinvestment of dividends in the equities themselves has been a superior strategy to value or growth since 1994.

Within Emerging Markets, Citi analysts see a brighter future for Chinese equities after a recent period of underperformance due to regulatory uncertainty and fiscal tightening.

Citi’s upgrades to the US and China came at the expense of two COVID-19 recovery allocations that have largely run their course. Latin American equities are up 63% since Citi analysts initiated an overweight in April 2020. Looking ahead, a largely unvaccinated population in Mexico and Brazil is worrisome. In addition, political uncertainty ahead of Brazil’s presidential elections may be met with foreign investor skittishness.

Furthermore, Citi analysts see the recovery in COVID-19 impacted equity REITs as nearly complete, though still favour certain sub-sectors like cell towers, data centers, industrial warehouses, residential, and health care. Citi analysts prefer active REIT management, as certain office and malls REITs are likely to face structural challenges in 2022 and beyond.